How Effective is Board Independence to the Monitoring of Earnings Manipulation?

Abstract

Earnings manipulation has become an effort of the firms to cosmetically conceal their earnings in order to achieve desired motive. The recent collapse of some large companies resulting partially from accounting manipulation has created an argument in term of the effectiveness of corporate governance mechanism toward investor protection. Effective corporate governance plays a key role to mitigate earnings manipulation. Therefore, boards have fiduciary responsibility to monitor the management to protect shareholders’ interest. They also become an essential element of corporate governance and are considered the main internal mechanism in reducing earning manipulation. The proportion of board independence are also a crucial part to reduce the tendency of earnings manipulation due to their ability to withstand pressure from the firm to manipulate earnings and are better able to monitor earnings process. Therefore, the purpose of this study is to examine the relationship between board independence and earnings manipulation by using Beneish profit model. This study employed the data from 372 Public Listed Companies in Malaysia from 2010 until 2013. The result of this study found that board independence has negative and significant relationship with earnings manipulation. These results indicate that higher number of independent directors will reduce the tendency of earnings manipulation. The finding of this study will be fruitful to industry by maintaining the appropriate numbers of directorship (independent non-executive directors) in the companies. Besides that, it may also assist the statutory bodies to strengthen and reinforce the composition of board of director in the companies.